Capital Gains Tax: What it Is, Rates, and More
What is Capital Gains Tax?
Capital gains tax is a tax levied on the profit made from the sale of a non-inventory asset, such as stocks, bonds, or real estate. The tax is only applicable when the asset is sold for more than its original purchase price, known as the "cost basis." The difference between the selling price and the cost basis is considered the capital gain, which is subject to tax.
For example, if you buy shares in a company for $1,000 and later sell them for $1,500, the $500 profit is your capital gain and will be taxed accordingly.
Short-Term Capital Gains Tax
Assets held for one year or less are subject to short-term capital gains tax. Short-term capital gains are taxed as ordinary income, which means you'll pay short-term capital gains according to your tax bracket. Here’s the breakdown of 2024 tax rates:
- 10%: Incomes under $11,600 or $23,200 for married couples filing jointly
- 12%: Incomes over $11,600 ($23,200 for married couples filing jointly
- 22%: Incomes over $47,150 ($94,300 for married couples filing jointly
- 24%: Incomes over $100,525 or $201,050 for married couples filing jointly
- 32%: Incomes over $191,950 or $383,900 for married couples filing jointly
- 35%: Incomes over $243,725 or $487,450 for married couples filing jointly
- 37%: Incomes over $609,350 for individuals or $731,200 for married couples filing jointly
Long-Term Capital Gains Tax
Long-term capital gains tax applies to assets held for more than one year. Long-term capital gains benefit from tax rates that are typically lower than regular income tax for most taxpayers, incentivizing them to hold onto their assets for at least a year. The rates are typically 0%, 15%, or 20%, depending on your income level.
In some cases, specific assets such as real estate may have additional tax benefits like exclusions on the first $250,000 (or $500,000 for married couples) of gain from the sale of your primary residence.
Capital Gains Tax Rates
Capital gain tax rates vary depending on how long you hold an asset before selling it, as well as your income level. As discussed above, short-term capital gains are taxed as ordinary income. On the other hand, long-term capital gains have a more favorable tax rate.
2024 Long-Term Capital Gains Tax Rates
| Filing Status | 0% Rate Amount | 15% Rate Amount | 20% Rate Amount |
|---|---|---|---|
| Single | $0 to $47,025 | $47,026 to $518,900 | Over $518,900 |
| Head of household | $0 to $63,000 | $63,001 to $551,350 | Over $551,350 |
| Married filing jointly | $0 to $94,050 | $94,051 to $583,750 | Over $583,750 |
| Married filing separately | $0 to $47,025 | $47,026 to $291,850 | Over $291,850 |
2025 Long-Term Capital Gains Tax Rates
| Filing Status | 0% Rate Amount | 15% Rate Amount | 20% Rate Amount |
|---|---|---|---|
| Single | $0 to $48,350 | $48,351 to $533,400 | Over $533,400 |
| Head of household | $0 to $64,750 | $64,751 to $566,700 | Over $566,700 |
| Married filing jointly | $0 to $96,700 | $96,701 to $600,050 | Over $600,050 |
| Married filing separately | $0 to $48,350 | $48,351 to $300,000 | Over $300,000 |
How to Calculate Capital Gains Tax
Calculating capital gains tax involves several steps. The exact amount you owe depends on the type of asset, how long you’ve held it, and your income level.
Here’s a simplified guide to help you calculate capital gains tax:
- Determine the sale price: The sale price is the amount you sold the asset for. This includes the amount you received from the sale, minus any associated selling costs, such as broker fees or commissions.
- Calculate the cost basis: The cost basis is the original purchase price of the asset plus any associated costs (e.g., improvements made to the property, transaction fees, etc.). For stocks or real estate, you may need to adjust the cost basis if you’ve reinvested dividends or made other adjustments to the value, such as by taking depreciation.
- Subtract the cost basis from the sale price: Remember, capital gain (or loss) = sale price - cost basis. If the result is positive, you have a capital gain. If it’s negative, you have a capital loss.
- Determine the holding period: If you held the asset for one year or less, the gain is considered short-term. If you held the asset for more than one year, the gain is considered long-term.
- Apply the appropriate tax rate: Short-term capital gains are taxed at your ordinary income tax rate, which ranges from 10% to 37% based on your income bracket. Long-term capital gains are taxed at a lower rate, which is typically—0% for lower-income earners, 15% for moderate-income earners, and 20% for higher-income earners.
- Consider additional taxes: Depending on your situation, you may also be subject to other taxes such as Net Investment Income Tax (NIIT), which is a 3.8% tax on capital gains for high-income earners, or state capital gains tax, which could vary from 0% to more than 10%.
Example Calculation
To help you better understand how to calculate capital gains tax, here’s an example calculation:
- Sale price of asset: $10,000
- Cost basis (purchase price + improvements): $6,000
- Capital gain: $10,000 - $6,000 = $4,000
If the asset was held for more than one year, the capital gain would be taxed as a long-term gain. If you're in the 15% tax bracket for long-term capital gains, the tax owed would be $4,000 x 15% = $600.
Using a Capital Gains Tax Calculator
Using a capital gains tax calculator can help you quickly and accurately determine the amount of tax you owe on the sale of an asset. It allows you to input details such as the purchase price, sale price, holding period, and applicable tax rates, and then provides an estimate of your taxable gain and the corresponding tax liability.
This tool is beneficial because it allows you to understand the financial impact of your sale ahead of time, helping you make informed decisions about whether to sell an asset or how to strategize for tax efficiency. Additionally, it can assist in identifying potential ways to reduce your taxable gain, such as offsetting losses or holding assets longer to qualify for more favorable long-term capital gains rates. However, it is always crucial to go over these numbers with a tax advisor after using the calculator tool as a guide.
How to Minimize or Avoid Capital Gains Tax
While paying taxes is unavoidable, there are several strategies to minimize the impact of capital gains tax:
- Hold investments for the long term: By holding assets for more than one year, you qualify for the lower long-term capital gains tax rates.
- Use tax-advantaged accounts: Contribute to retirement accounts like IRAs or 401(k)s, where you can defer taxes on capital gains until retirement.
- Offset gains with losses (tax-loss harvesting): You can sell investments that have lost value to offset taxable capital gains. This strategy helps reduce your taxable income.
- Utilize the primary residence exclusion: If you're selling your primary home, you can exclude up to $250,000 of gain ($500,000 for married couples) from capital gains tax, provided you meet certain conditions.
- Gift assets: Consider gifting appreciated assets to family members in lower tax brackets to reduce your overall tax burden.
FAQs About Capital Gains Tax
Check out some frequently asked questions below to learn more about capital gains tax.
What’s the difference between short-term and long-term capital gains?
Short-term capital gains occur when you sell an asset that you've owned for one year or less, and they are taxed at your ordinary income tax rate. In contrast, long-term capital gains apply to assets held for more than one year and are taxed at a more favorable rate, encouraging longer-term investments.
Are capital gains tax rates the same in all states?
State-level capital gains tax rates vary by state. While some states, like Florida and Texas, have no state income tax, others, like California, have high state capital gains taxes that can significantly increase your total tax liability. It's important to consider both federal and state tax implications when selling assets, as the combined taxes may vary depending on where you live.
Do I have to pay capital gains tax if I sell my primary residence?
You may be able to exclude some or all of your capital gains when you sell your primary residence, thanks to the primary residence exclusion. If you meet certain criteria, you can exclude up to $250,000 in gains ($500,000 for married couples filing jointly) from capital gains tax. To qualify, you must have lived in the home for at least two out of the last five years before selling. If your gains exceed this amount, the excess will be subject to capital gains tax.
At what age do you not pay capital gains?
There is no specific age at which you automatically stop paying capital gains tax. Since capital gains taxes apply regardless of age, it’s essential to review your income level, asset holdings, and other factors to determine your specific tax liability. Always consult a tax advisor for personalized advice.
Make Sure You Understand How Capital Gains Tax Works
Capital gains tax is an essential part of the investment landscape that can impact how much of your profit you get to keep. By understanding the tax rates, the strategies available to reduce your tax liability, and the specific rules that apply to different types of assets, you can make more informed decisions and keep more of your earnings. Always consult with a tax advisor or financial planner to ensure you’re using the most effective strategies for your unique financial situation.
A 1031 exchange can help you defer capital gains tax on the sale of an investment property when you reinvest the proceeds into a like-kind property. To learn more about how this process works, contact First American Exchange Company today.